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 MARKET REPORTS |
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Analyst report - shares
Stock of the week: Macmahon Holdings
April 7, 2008
Tim Morris, wise-owl.com analyst
Stock: Macmahon Holdings
Recommendation: Buy
Code: MAH
Market Cap: $800m
With share prices at the smaller end of the market remaining hostage to enforced margin selling in a low liquidity environment, we maintain our bias towards the big end of town. Under the spotlight this week is Macmahon Holdings, supplier of infrastructure and mining construction services.
The company was founded in 1963 by Adelaide civil engineer Brian Macmahon. Macmahon listed on the Australian Stock Exchange way back in 1983 when revenue had grown to $77 million and the employee headcount totalled 1000. In what can be a very cyclical industry, the company has experienced its fair share of downturns, which long-term shareholders would be familiar with. As 1992-94 and 1999-01 were both challenging loss-making periods for the company, the long term share price performance has been mixed.
However, from lows of 7.7c in 2001 the stock rallied to all time highs of $2 in November last year on the back of the resources bull market. With the share price now sitting comfortably below this high, and the outlook for infrastructure and mining construction remaining buoyant (despite what the overall markets’ performance may imply), it’s time to consider the outlook for shareholders.
A new look management team at the start of the decade combined with the China-led revival of commodities prices from 2003, has blown a breath of fresh air into Macmahon over recent years. Underlying net profit has risen from $8.5m in 2003 to $33.4m in 2007 on the back of strong revenue growth and margin expansion.
The growth was witnessed across both key business segments – mining and construction. The mining business provides a total mining service for open cut and underground operations, while the construction business provides services across the many facets of civil engineering such as road, rail and water infrastructure.
Western Australia and the Northern Territory are Macmahon’s traditional markets; however the company’s footprint has been expanding eastward. Macmahon has been working in South Australia on BHP’s mammoth Olympic Dam project since 2003, and more recently has won several key breakthrough contracts in the eastern states. The growth potential across each of these new and established markets is strong. Western Australia’s capital works programme for the next four years will be $21.6bn, with $5.8bn forecast to be spent in 2007/08.
Opportunities in South Australia will continue to surface as the Olympic Dam development progresses and attracts other mining investment. While along the east coast, the opportunities should arise from heavy government infrastructure investment, with Queensland committing $10bn to road, rail and water projects over the next year, while NSW has flagged a $50bn spend over the next 4 years.
Increasing market share on the east coast to take advantage of these growth opportunities is a key part of the company’s strategic plan through to 2012. The five year plan focuses on growing revenue and profits, both organically and through acquisition, at a targeted rate of 20-30% per annum. At its most recent half year results announcement, which surprised the market on the upside, with profits up 59%, management asserted that the company was on track to achieve 30% growth in the current year and 20-30% in 2009.
This bullish outlook is based on the company’s record order book, which at December 31 stood at over $2bn, or more than 2 times revenues. A closer look at these contracts reveal that Macmahon’s top four customers represent approximately 86% of the order book, when governments are grouped as one entity. Government’s account for 36% of orders, BHP 26% and Rio Tinto 9%. Although this lack of diversification is a risk, we feel the blue chip nature of the client base provides alleviating comfort for investors.
In February, the order book received a significant additional boost, as Macmahon secured a $1.1bn contract for Moly Mines (ASX code: MOL) Spinifex Ridge mine. Work is scheduled to commence once Moly Mines receives financing for the project, which was recently delayed due to poor credit market conditions.
Large contracts such as Moly Mines are set to become Macmahon’s target moving forward following last years agreement with Leighton Holdings (ASX code: LEI), which saw Leighton acquire a 14.9% stake in Macmahon. The agreement between the companies will see Leighton promote Macmahon as a partner of choice for large infrastructure and resource related projects.
The agreement should accelerate Macmahon’s penetration along the east coast by allowing the company to become involved in large joint venture projects much faster with less risk, due to Leighton’s considerable experience at this level. Up until now, revenue from large construction joint venture projects has made up less than 10% of Macmahon’s annual revenue and this agreement has the potential to significantly increase that contribution during the next few years.
Considering these recent developments and the operating environment, there is no denying that the outlook for the company itself is bullish. However to contemplate the outlook for Macmahon’s share price, we need to consider the valuation. The stock is trading on a current PE of 26.7 and a forward PE of 17.9, which is a premium to the engineering and construction sector and suggests that some, but not all of Macmahon’s prospective growth has been ‘priced in’. Interestingly, these multiples are very similar to those which Leighton is trading on. In our view, the share price currently takes into account the certainty of revenues over the next few years from the record order book and some additional contract wins. However, we feel the impact of larger contract wins arising from the agreement with Leighton are yet to be appreciated, which is why we rate it a high risk ‘buy’.
The current valuation premium poses one of the biggest risks to the share price, as should earnings take an unexpected turn for the worse, history shows that Macmahon’s PE can fall into the single digits. Debt troubles are a low risk as the company has reduced its gearing (net debt to equity) significantly over recent years from 119% in 2003 to current levels of 18.7%, which is very modest. The other risk to consider is associated with the recently secured Moly Mines contract, where delays in securing project financing may push back work on Spinifex Ridge, potentially impacting the timing the contract’s proceeds.
Tim Morris is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
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Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
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